A Close Look at Post-Merger Airline Stocks

By Sam Mamudi

With the deal to merge US Airways (LCC) and American Airlines parent AMR (AAMRQ) seemingly close to completion, analysts David Fintzen and Isaac Husseini at Barclays Equity Research have published a note that looks at how airline stocks perform in the wake of an industry merger.

Here’s the juicy lede, as it were:

On average, non-deal airline stocks have performed well following an announcement (17% outperformance vs. S&P 500 one month after an announcement). However, a deeper look shows wide divergence and, perhaps not surprisingly, macro and fuel dynamics have often overshadowed merger news. Given the widespread media attention on an AMR/LCC merger over the last 14 months and the recent run-up in airlines, there is always a risk that this time could be different given. To the extent airline stocks in general are weak following any potential announcement, we’d be buyers of Delta Air Lines (DAL) and Southwest Airlines (LUV).

Their hesitance to recommend the whole sector is well-founded: For example, while the airline sector outperformed the Standard & Poor’s 500 index by about 18 percentage points in the weeks following the announcement of United-Continental merger that created United Continental Holdings (UAL), much of that was due to US Airways’ soaring share price; Southwest and Delta stocks only rose by single digits.

But caveats aside, we’ve certainly seen outperformance in the lead up to the latest (likely) merger:

(Click for larger version.)

The question is how much the recent gains are in expectation of another industry merger, and the extent that would dampen post-merger price rises.

In our view, the recent rally in airline stocks is a result of valuation catching up with improving fundamentals. In fact, at the end of 2012, airlines closed the year at an EBITDAR multiple of 5.4x, which was ~14% below what we view as the fair value multiple based on the margin/multiple relation. Moreover, year-to-date performance of airlines translates to an EBITDAR multiple of 4.6x, which is ~16% below the fair value multiple.

In other words, these increases are more about fundamentals and value, and the merger-mania gains are yet to come.

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Earnings reports, corporate strategies and analyst insights are all part of what moves stocks, and they’re all covered by the Stocks to Watch blog. We also look at macro issues, investor sentiments and hidden trends that are affecting the market. Stocks to Watch gives you the full picture of the U.S. stock markets, all day long.

The blog is written by Ben Levisohn, a former stock trader who has covered financial markets for the Wall Street Journal, Bloomberg and BusinessWeek.